Abstract
In this paper, we develop a dynamic model of optimal investment for shareholders by using the utility-indifference pricing theory. The marginal value of cash holdings is measured in shareholder’s marginal utility of cash. The model predicts that the marginal value of cash varies negatively with the stock price, and positively with the volatility of the stock price. We then test this model using a sample of 453 Chinese Listed Companies from 1999 to 2012. Consistent with the model, we find the same quantitative relationship between the marginal value of cash and the stock price, the volatility of the stock price. The effect may offer a new method to predict the changes of stock price in practice. Our conclusions may also support that cash holdings are more valuable for financially constrained firms than unconstrained firms.
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